By Ryan Gilmer, CFA – VP Investment Management – TOPS ETF Portfolios

Anyone who has ever entered a March Madness bracket pool for the NCAA tournament knows the feeling – it doesn’t take long before the teams you’ve picked to win start to lose – and your bracket fills up with red.

After the first weekend, most brackets have lots of mistakes. It’s easy to see why. The teams in the tournament are all pretty good, or else they wouldn’t qualify.

The difference between the teams isn’t that large, making it hard to predict with certainty who will win. Also, the first round alone has 32 games, so it’s going to be very difficult to make many correct predictions. Jeff Bergen, a professor at DePaul, estimates the chances of picking a perfect bracket at 1 in 128 billion. Many think the odds are worse than that.

My bracket strategy has changed over time. At first, it was fun to try and pick upsets. After all, upsets happen every year, so I knew a reasonable amount of the lower seeded teams would defeat higher seeds. Furthermore, picking an upset meant being contrarian. If anything, picking upsets gave me bragging rights with my friends.

The upset strategy had problems though. First, every upset that I picked was a low probability event, which meant that the favored team was likely to win, and I was likely to be wrong. Second, given the sheer number of games played in the tournament, it was likely that upsets I didn’t pick would occur, doing further destruction to my bracket.  Most years, in the attempt to make my bracket better, I compounded my problems and made it worse.  Needless to say, I didn’t end up feeling smarter than my friends.

Related: ETF Issuer March Madness

So now, I have a new bracket strategy. I only pick the favored teams to win. My motivation is no longer to pick the perfect bracket, a task which is highly unlikely, if not impossible. My new goal is to give myself the best possible chance of success. I know there will be upsets, but I also know that my chances of picking upsets regularly are not good. I am certainly not a college basketball expert, but even so-called experts have questionable ability to pick upsets consistently. Most of the time, the favored teams win, if they didn’t Vegas would be broke.

So, I’ve decided to align my bracket with the favorites. If you are trying to win your office pool, this strategy gives you the best statistical chance for success.

Every year, S&P Global updates the SPIVA US Scorecard. This report tracks the percentage of actively managed funds that outperform their index benchmark. It corrects for survivorship bias by adding back any funds that were liquidated or merged. It also assigns appropriate benchmarks and asset-weight returns, meaning the biggest funds have more impact than smaller funds. This methodology is used to accurately show what results most investors are getting.

Reports 1, 6, and 11 show the results of the study:

Report 1: Percentage of US Equity Funds Outperformed by Benchmarks
Fund CategoryComparison Index1-Year %3-Year %5-Year %10-Year %15-Year %
All Domestic FundsS&P Composite 150063.43%83.40%86.72%86.65%83.74%
All Large-Cap FundsS&P 50063.08%80.56%84.23%89.51%92.33%
All Mid-Cap FundsS&P MidCap 40044.41%86.34%85.06%96.48%94.81%
All Small-Cap FundsS&P SmallCap 60047.70%88.83%91.17%95.71%95.73%
All Multi-Cap FundsS&P Composite 150056.46%83.64%84.91%90.70%87.67%
Large-Cap Growth FundsS&P 500 Growth32.92%67.58%80.92%93.65%93.49%
Large-Cap Core FundsS&P 50068.98%88.45%90.99%94.95%94.67%
Large-Cap Value FundsS&P 500 Value46.88%80.37%85.07%70.44%85.71%
Mid-Cap Growth FundsS&P MidCap 400 Growth18.05%91.46%81.13%97.69%95.32%
Mid-Cap Core FundsS&P MidCap 40061.67%88.24%87.90%96.15%96.51%
Mid-Cap Value FundsS&P MidCap 400 Value43.14%75.41%81.54%88.04%88.89%
Small-Cap Growth FundsS&P SmallCap 600 Growth15.08%86.53%86.67%95.56%98.73%
Small-Cap Core FundsS&P SmallCap 60058.59%93.78%95.59%96.23%96.55%
Small-Cap Value FundsS&P SmallCap 600 Value74.07%82.14%95.45%92.78%89.47%
Multi-Cap Growth FundsS&P Composite 1500 Growth46.32%83.24%85.11%94.77%86.21%
Multi-Cap Core FundsS&P Composite 150068.78%92.78%90.13%90.14%90.82%
Multi-Cap Value FundsS&P Composite 1500 Value49.57%76.47%76.24%84.21%85.96%
Real Estate FundsS&P United States REIT36.90%59.76%73.68%84.54%81.13%
Source: S&P Dow Jones Indices LLC.  Data as of Dec. 29, 2017. Returns shown are annualized. Past performance is no guarantee of future results.
Table is provided for illustrative purposes.

 

Report 6: Percentage of International Equity Funds Outperformed by Benchmarks
Fund CategoryComparison Index1-Year %3-Year %5-Year %10-Year %15-Year %
Global FundsS&P Global 120050.21%77.45%77.71%81.98%82.47%
International FundsS&P International 70053.95%69.40%70.93%81.68%91.63%
International Small-Cap FundsS&P Developed Ex-US Small Cap44.05%65.75%65.52%72.55%78.13%
Emerging Markets FundsS&P/IFCI Composite64.89%78.92%77.78%85.14%94.83%
Source: S&P Dow Jones Indices LLC.  Data as of Dec. 29, 2017. Returns shown are annualized. Past performance is no guarantee of future results.
Table is provided for illustrative purposes.

 

Report 11: Percentage of Fixed Income Funds Outperformed by Benchmarks
Fund CategoryComparison Index1-Year %3-Year %5-Year %10-Year %15-Year %
Government Long FundsBarclays US Government Long96.43%100.00%98.31%95.24%98.00%
Government Interm FundsBarclays US Government Interm57.89%90.91%80.00%78.05%90.48%
Government Short FundsBarclays US Government (1-3 Year)47.83%69.23%79.31%76.47%88.24%
Investment-Grade Long FundsBarclays US Government/Credit Long96.74%94.68%95.45%95.40%97.73%
Investment-Grade Interm FundsBarclays US Government/Credit Interm31.37%35.53%40.94%51.06%73.53%
Investment-Grade Short FundsBarclays US Govt/Credit (1-3 Year)22.22%41.67%43.33%57.81%68.89%
High Yield FundsBarclays US Corporate High Yield80.95%90.87%93.81%98.37%98.23%
Mortgage-Backed Securities FundsBarclays US Aggregate Securitized MBS67.92%73.08%79.31%81.40%93.88%
Global Income FundsBarclays Global Aggregate64.86%60.55%52.59%58.33%69.44%
Emerging Markets Debt FundsBarclays Emerging Markets22.58%70.69%85.71%73.68%66.67%
General Municipal Debt FundsS&P National AMT-Free Muni Bond42.86%58.75%47.50%63.29%82.88%
California Municipal Debt FundsS&P California AMT-Free Muni Bond25.71%30.56%37.14%66.67%84.44%
New York Municipal Debt FundsS&P New York AMT-Free Muni Bond33.33%57.14%73.33%85.29%89.47%
Loan Participation FundsS&P/LSTA US Leveraged Loan 10052.08%56.25%52.78%100.00%
Source: S&P Dow Jones Indices LLC.  Data as of Dec. 29, 2017. Returns shown are annualized. Past performance is no guarantee of future results.
Table is provided for illustrative purposes.

 

Each table shows the percentage of active funds that failed to beat the benchmark over the given time period.  Just like the NCAA tournament, there can be upsets over shorter time periods.  Even so, the results indicate just how difficult it is for most active funds to continue to outperform, especially over longer time periods and full market cycles. It also shows how this phenomenon persists over most asset classes, including diversifying holdings such as emerging market debt and international stocks, which have long been thought to benefit from active management.

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